Alternative to a Certificate of Deposit

by Keith Evans

Investors have a number of low-risk and high-risk alternatives to CDs.

Certificates of deposit provide a relatively safe investment vehicle for individuals and companies hoping to save money while earning a small return. Though CDs are an attractive option for risk-averse investors, a number of alternatives can provide safer investment vehicles with lower yield, or higher yields accompanied with higher risk.

Money Market Accounts

Investors who prefer the security of a CD or a savings account but demand higher yields may prefer a money market account. Money market accounts work much like savings accounts in that investors simply create an account and deposit funds into it. Financial institutions typically place more restrictions on money market accounts, though, and may require very high opening balances with limited withdrawal privileges. These restrictions allow the bank to more liberally invest the deposited funds, rewarding account holders with higher interest rates.

Bonds

Often considered one of the safest investment vehicles available, bonds provide an opportunity for investors to earn a small return while minimizing risk. Either government or corporate entities can issue bonds, and they work much like loans; when an investor buys a bond, he becomes a creditor to the bond issuer. Bonds typically feature a fixed term, and the investor may redeem the bond for capital and interest at the maturity date. Some bonds, known as consol bonds, perpetually accrue interest and allow the investor to continue earning until redemption.

Bundled Mortgages

Investors who can tolerate a little more risk can profit from investing in bundled mortgages. When financial institutions issue mortgage loans, they rarely continue ownership of the loan throughout the duration of the mortgage. Instead, banks frequently bundle mortgages into securities and sell them to institutional and individual investors through brokerage firms. Investors who buy mortgage-backed securities receive periodic payments equal to a fraction of the borrower’s monthly payment, typically amounting to capital plus interest when the mortgage becomes fully paid. Though the U.S. Government backs mortgage securities through its Ginnie Mae arm, but investors can still lose funds if the borrower defaults early in the mortgage term.

Peer-to-Peer Lending

A relatively newer investment vehicle, peer to peer lending, allows individual investors to realize high interest yields comparable to those commercial lenders may enjoy. Peer to Peer borrowers request loans through specialized platforms, and investors can fund the loans in increments as low as $25. As the borrower repays the loan, the investor receives periodic payments on the invested funds; over the term of the loan, investors often receive the invested capital and interest rates that can reach higher than 15 percent. Though Peer to Peer lending platforms often feature extensive collection practices when borrowers default, the unsecured loans can leave investors with hefty losses if many borrowers fail to repay.